Fallacies I've Known and Loved: "It costs 5 times as much to acquire a customer than to retain one"

This is perhaps the apparent truism that I hear about every month, and that is the most ingrained in people's minds. I'd like to see proof that acquiring a customer is five times as expensive as retaining one as, for the life of me, I cannot come up with an example that verifies this fallacy. And it doesn't matter if the proportion is five times or two times, I cannot find a way to justify this fallacy, nor have I come across someone that could.

But let me edge my bets as well: even if acquiring a customer required a fivefold investment over retaining one, why is that necessarily bad? Wouldn't a rational Marketing manager be more interested in prospective customer value and ROI than on pure cost??

Let's take a closer look at this fallacy: to ease our task let's decompose it into four elements:

• acquisition and retention work the same way across industries - this is clearly not a fact and we also need to distinguish between sales to business versus sales to the consumer. I can see that setting up and servicing a new B2B account requires some overhead that is not present in B2C; yet, this is an expense that has to be incurred for every customer; moreover, the cost of servicing each new order from existing customers is mostly likely comparable to the set up costs. In B2C this argument makes no sense: most of us become customers of any merchant probably as much out of need and convenience as a result of advertising.
• acquisition expenses are greater than those for retention by a significant factor - this is the part I really do not understand: the fixed costs are shared equally by both existing and prospective customers, the variable costs that go into retention are related to account servicing in a B2B environment and to advertising in B2C, the corresponding costs for acquiring new customers are sales costs in B2B and ... advertising in B2C! If the distinguishing cost item between retention and acquisition is advertising, then something is very wrong with a department than spends 5 times as much to acquire a customer than to retain one... it goes without saying that all that fantastic customer satisfaction that we have to retain customers costs an additional amount (an amount that is not attributed to new customers)
  
• retention and acquisition costs are more important than customer value - even if the cost differential were more than 5-multiplier, it might still be justified in face of the prospective value that each client brings to a company. As pointed in the first item above, this is a fallacy that suffers from a crippling impulse to generalize: in a high margin industry it may be justifiable to spend a considerable amount to acquire customers, think for instance, of a Bentley dealership: the cost of spending a few bottles of Veuve Clicquot and a half pound or Russian beluga caviar on each new customer pales in comparison with the momentous margin brought in by each sale
• business and product lifecycles require different tactics - companies that are new to a given market must invest in acquisition, costly or cheap, they will only gain a foothold in the market if they acquire customers; similarly a new product can only gain acceptance if there is an expenditure in acquiring customers. Retention works well for established companies whose business is waning and for products that are becoming commodified.

What does all this means to Marketers? A few simple items to bear in mind:

• quit repeating the fallacy - it is not necessarily accurate nor true, and you may find yourself in a bind having to prove it to a more hawkish client
• snap off the "one size fits all" frame of mind - different products and different industries have their own needs and these become more distinct as strategies morph into tactics and into operational plans
• design and implement contact strategies that address the business problem rather than some unproven "tribal knowledge".

Comments

[Jim Novo]

The general truism "it costs 5x more to acquire a customer than retain one" is from Fred Reichheld's (yes, he of NPS fame) earlier book, The Loyalty Effect (1996). It's based on his study of 25 different companies across many different industries - State Farm, Toyota, John Deere, Leo Burnett, Enterprise Rent-a-Car, MBNA, Chic-Fil-A, etc. when he was at Bain & Co. This book is also the source of the "5-point increase in retention lifts per-customer profit by more than 125 percent" type of idea.

To clarify, this "5 to 1" phrase has been hacked up and taken out of context for more than a decade. The original meaning is the yield on a dollar spent is 5x higher for retention than acquisition; the ROI is 5x higher for retention than acquisition.

Granted, we're talking about purely offline activity at the time these studies were carried out, but as acquisition costs may have fallen online, retention rates online are terrible, much worse than offline. So the 5 to 1 ratio may still be roughly true, though from what I have seen it is even more exaggerated in favor of retention online, for example:

http://blog.jimnovo.com/2007/03/12/new-customer-kits/

The reason for this exaggerated effect online? Since retention is so horrible online - and so few companies do anything about it - just about any dollar you spend to retain a customer online has a dramatic effect on customer behavior.

I don't think anybody in the retention camp is suggesting that a company stop acquiring customers, and as you said, this scenario is more applicable to mature companies than new ones. But companies do get to a point where spending the incremental dollar on acquisition rather than retention doesn't make any sense since they simply churn those newly acquired customers out. This company should optimize retention first (which is not always a Marketing exercise) in order to make the acquisition dollars work harder for them - and this is the real point. There is a tremendous amount of spend waste in acquisition if you simply flush a ton of new customers after they are acquired by failing to retain them. You need a balance in spend between acquisition and retention to optimize the system.

I'm more a fan of Reichheld's earlier work because it's all about the Math and relies less on people's opinions than the NPS does. I suspect the NPS idea is probably a market-oriented reaction to the inability of so many companies to in fact do the Math. Most pure online companies should easily be able to do the Math though...

[Bhupendra]

Interesting discussion going on. I liked the posts but I don't think I agree with the concepts here.

The acquisition and retention depends on the time frame where a company is running. For a startup company, the acquisition makes more sense, but for a mature company retention will be a bigger factor. I have seen that if a company is able to acquire more customers at any time, the it is able to retain too unless the policy of the company is too much focussed solely on acquisition.

Let us take a Retail Chain as an example. The better offers with good in-store service is likely to attract both old and the new ones.
Vice versa may be true too. If the company focuses too much on retention and provides huge benefit to the loyal customers, then the word of mouth spreads and along with retention the new customers count will increase.

In other markets also same thing happen. The difference comes when the store is not performing well due to some external factors. The marketers and analysts try many ways to acquire and retain customers but even with the new offer they don't win the competition. Then they start bring demarcation in retention and acquisition. And they fail further.

I would say, if anyone says acquiring is different from retention, he is defensive. He is getting too judgmental and is going to lose further.